5 Stocks Everyone Hates -- But You Should Love - views

BALTIMORE (Stockpickr) -- The stocks that everyone else hates could make you rich.

That sounds like an outlandish claim, I know. But as any contrarian investor knows, when sentiment against the most heavily shorted stocks reaches extremes, it’s often a good idea to bet against the crowd. And the crowd has been making big bets against a handful of stocks in 2012.

But there’s more to it than just that. It’s not just an opinion -- the data bear the strategy out as well.

Taking a look at the last decade, buying heavily shorted large and mid-cap stocks (the top two quartiles of all shortable stocks by market capitalization) would have beaten the S&P 500 by 9.28% each and every year. That’s some material outperformance during a decade when decent returns were very hard to come by.

It’s worth noting, though, that market cap matters a lot – short sellers tend to be right about smaller names, with micro-caps delivering negative returns when the same strategy was used.

Today, we’ll replicate the most lucrative side of this strategy with a look atfive big-name stocks that short sellers are piled into right now.

In case you’re not familiar with the term, a “short squeeze” is the buying frenzy that ensues when a heavily shorted stock starts to look attractive again to investors, causing share price to skyrocket. One of the best indicators of just how high a short-squeezed stock could go is the short interest ratio, which estimates the number of days it would take for short-sellers to cover their positions. The higher the short ratio, the higher the potential profits when the shorts get squeezed.

Naturally, these plays aren’t without their blemishes -- there’s a reason (economic or otherwise) that these stocks are being heavily shorted. But for investors looking for exposure to a speculative play with a beefier risk/reward tradeoff, these could be powerful upside plays for the coming year.

First up is $14 billion restaurant chain Chipotle Mexican Grill (CMG). Chipotle has been one of the biggest success stories in the restaurant industry, churning out fast-paced growth and major profitability during a time when other names were struggling.

But with shares off by more than 15% this year, are the shorts right about downside in Chipotle? Doubtful.

Chipotle operates in the fast-casual segment of the market, a model that fills the space in between fast food chains and casual dining restaurants. That’s proven to be a successful model in our post-recession world, with consumers trading down on their dining choices but looking for something healthier and more exciting than the traditional fast food joint.

With approximately 1,300 restaurants in 42 states and four countries, CMG has proven its willingness to dip a toe into new markets. While international exposure is a good thing, North American growth is the most important avenue for expansion in the next several years. With room for the firm to more than double the number of stores it has stateside before it starts to saturate the market, there’s a good reason for the hefty earnings multiple investors are paying right now.

Better still, Chipotle has almost exclusively used cash from operations to finance its growth so far, maintaining an immaterial amount of debt on its balance sheet that’s more than offset by a nearly $700 million cash and investment position. Short sellers have been betting against this stock en masse. While the firm’s short interest ratio only sits at 4.6, indicating that it would take a week for shorts to cover, more than 12% of CMG’s total float is short right now.

That makes the firm a prime candidate for a short squeeze right now.

Under Armour

Athletic apparel firm Under Armour (UA) is another stock that’s getting hefty attention from short sellers right now. UA currently boasts a short interest ratio of 10.9, a number that indicates it would take more than two full weeks of buying pressure for shorts to cover their bets at current volume levels. And with the stock up more than 63% so far in 2012, short sellers are probably getting pretty exhausted right now.

Under Armour has built itself into a recognizable high-end apparel name that’s able to compete against the likes of Nike (NKE), the industry’s standard-bearer. UA’s approach is technology-driven, with its signature moisture-wicking performance fabric being one of the most imitated offerings among its peers. As the firm adds new products to its portfolio (its foray into footwear was a big move it made a few years ago), it should be able to expand its top line in existing markets, while at the same time pushing to altogether new markets for the firm.

Financially, UA is another stock that’s in stellar shape. With more than $142 million in cash, and just half that in debt, UA’s net cash position gives it plenty of dry powder to deal with any industry headwinds right now. And since cash is like kryptonite to short sellers, UA’s growing coffers have the potential to trigger covering in this heavily-shorted stock.J.C. PenneyJ.C. Penney (JCP) is a stock in transition right now. The 110-year-old department store chain got investors excited when it announced that it had poached Apple’s (AAPL) retail head, Ron Johnson, but much of that excitement has dissipated since. Investors have notoriously little patience, and I guess the turnaround plan is taking longer than they’re willing to take.

While JCP’s short interest ratio is only 4.5, a staggering 41.5% of float is short right now.

Believe it or not, Penney has been making some big changes. From the new advertising initiatives designed to pull in a trendier, younger demographic to a new merchandising strategy behind the scenes, JCP is working hard to break out of the weak market position that it’s found itself in over the last few years. By positioning itself as a place to find fashionable bargains, JCP’s approach looks a lot like that of Target (TGT), another of Ron Johnson’s old haunts.

It’s a good strategy, but it’s one that’s dependent on merchandising to pull off. That’s why Johnson’s expertise in merchandising should come in very handy.

While JCP’s balance sheet isn’t as pretty as the books are at the other two stocks we’ve looked at already, the firm’s financials look a lot better than most of its peers. That wherewithal should give JCP the time it needs to complete its turnaround.

Lennar

Homebuilders haven’t exactly won the favor of most investors over the last few years. Lennar (LEN) is no exception -- the $6.2 billion builder focuses on the entry level of the housing market, building value-focused homes across the country.

That positioning is a big part of why the firm’s short interest ratio sits at 7.9; right now, it would take almost two weeks of frenzied buying for short sellers to cover their bets against this stock.

While positioning along the low end of the housing spectrum meant that Lennar went through some post-bubble pain, the firm’s positioning looks good now. It’s a buyer’s market, and potential homeowners are looking for value -- an offering that’s right up Lennar’s alley. The firm’s balance sheet is rife with attractive property that’s ready for development, as well as finished homes that it’s moving at an increasingly quick rate right now.

Like most of its peers, Lennar bit the bullet back in 2008 and 2009, getting rid of properties on its balance sheet at small profits or at losses just in order to build its cash reserves back up. Now, with around $1.4 billion in cash and investments offsetting a $4 billion building debt position, the firm is in solid enough financial shape to make it through any economic turbulence. That positioning makes the firm a good short squeeze candidate.

Safeway

Last up is mid-cap grocery chain Safeway (SWY), a stock that’s lived up to short sellers’ expectations this year, slipping more than 24% since the first trading day in January. But as this stock has slid, more shorts have piled in, ratcheting SWY’s short interest ratio to 12. That glut of late-to-the-game short sellers makes this stock a solid short squeeze candidate.

Safeway is one of the best-in-breed stocks in the conventional grocery business. The firm’s nearly 1,700 stores are spread across much of the U.S. and Canada, giving the firm plenty of geographic diversification. At the same time, the firm has been a leader in private label brands and so-called “Lifestyle” store upgrades that cater to a higher-end customer. Those two changes should be a big source of margin growth for Safeway, which operates in an industry where margin cushion is paramount.

Like other grocers, Safeway isn’t earning massive margins; instead, it slices a slim profit off of each item that it sells. While shorts have been arguing that cost inflation should shove SWY’s margins negative, management has proven adept at keeping the firm’s earnings positive.

That’s also helped to fuel a 4.4% dividend yield that’s huge for the grocery industry. Remember, cash is kryptonite for short sellers. With ample balance sheet liquidity for buybacks and dividend payouts, shorts could see their potential profits get eroded if Safeway continues to perform as it has.

At the time of publication, author had no positions in stocks mentioned.

Jonas Elmerraji, based out of Baltimore, is the editor and portfolio manager of the Rhino Stock Report, a free investment advisory that returned 15% in 2008. He is a contributor to numerous financial outlets, including Forbes and Investopedia, and has been featured in Investor's Business Daily, in Consumer's Digest and on MSNBC.com.